Thursday, 30 July 2015

Find this guy a girlfriend, for $10,000

Tyler Cowen occasionally posts something riotously funny (at least, to me!). Earlier this month, he posted:
This man is bidding 10k for a girlfriend, but I don’t think he understands where the adverse selection problem lies.
At the risk of dragging out the joke, I'll explain. From the linked article on Business Insider Australia:
This Alabama man has been on 30 unsuccessful dates in the past the past ten months — to remedy this situation, he created a website offering a $US10,000 reward to anyone who can find him a girlfriend.
Ren Lu You is a 29-year-old living in Birmingham, Alabama...
Even though he was going on plenty of dates, he wasn’t meeting the kinds of women he envisioned potentially spending the rest of his life with.
“With online dating you have this problem of adverse selection,” You explained. “Only the people who self-select into a particular dating website are the people you have access to.” 
Adverse selection arises when there is information asymmetry - specifically, there is private information about some characteristics or attributes that are relevant to an agreement, and that information is known to one party to an agreement but not to others. In the case of online dating, the 'agreement' is a relationship (or even a single date) and the private information is about the quality of the person as a potential date - each person with an online dating profile (the informed party) knows whether they are a high-quality date or not, but the others who might match with them (the uninformed parties) do not.

An adverse selection problem arises because the uninformed parties cannot tell high quality dates from low quality dates. To minimise the risk to themselves of going on a horrible date, it makes sense for the uninformed party to assume that everyone is a low-quality date. This leads to a pooling equilibrium - high-quality and low-quality dates are grouped together because they can't easily differentiate themselves. Which means that people looking for high-quality dates should probably steer clear of online dating.

Signalling is one way that markets have adapted to deal with adverse selection problems. With signalling, the informed party finds some way to credibly reveal the private information to the uninformed party. There are two important conditions for a signal to be effective: (1) it needs to be costly; and (2) it needs to be more costly to those with lower quality attributes. These conditions are important, because if they are not fulfilled, then those with low quality attributes could still signal themselves as having high quality attributes.

Now, consider Ren. Women don't know whether Ren is a high- or a low-quality date (this is the private information). He offers the $10,000 prize to try to signal he is high quality. Sure, this is costly. But a low-quality date can offer a $10,000 prize too - the prize doesn't distinguish Ren's quality as a future boyfriend. However, consider this - would a high-quality date have to offer $10,000 in order to attract a girlfriend? If Ren wants girls to believe he is a high-quality date, he is clearly providing the wrong signal.

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